High Return Investments: Just Another Word for Scam

Updated on January 27, 2012

Be very careful whenever you hear the words high return investments. The odds are that the moment those words are uttered you are being scammed.

Many investors do, in fact, earn high returns. But the unhappy truth of markets is that unless you are a real insider trading every day with access to information that the rest of us just will never have, you will be better off as a patient investor than one who is always chasing the latest fads. And when someone is selling you an investment that is guaranteed to make a lot of money quickly, be very very careful indeed. Wall Street is full of incredibly smart people. If there was a guaranteed way to make money quickly by investing, they would have already found the investment.

What you need to think about is making money slowly through investing. Lets start with the secrets of two of the greatest investors in the world.

Warren Buffetts Secrets for High Return Investments

Many people assume that high return is linked to high risk. They are right. Anyone who tells you something different is generally wrong. But there is one exception to this rule and that is to follow the methods of finding deeply undervalued stocks which is strategy followed by Warren Buffett, the world's most successful investor.

Now investment markets always involve a balance between fear and greed.
Warren Buffett is famous for
saying that you should be greedy when others are fearful and fearful
when others are greedy. That is sound investing advice. But you will
probably also note that he almost never talks about or promises a high
return on investment. When it comes to investing his money he is
actually a remarkably conservative investor. He doesn't look for stocks that are growing fast, or for businesses that will invent the next big thing. Instead he looks for good old fashioned companies in industries that he understands well that are trading at far below what he thinks their intrinsic value is. He isn't looking to double his money in a year, although he has done that on occasion, but he is looking for good, solid returns that will come in year after year. The power of compound growth means that mid-teen returns for an extended period of time lead to astronomical exponential growth.

Another point that he makes is to look for a margin of safety when buying stocks. In this he his going back to the philosophy of the father of value investing, Ben Graham, who always looked for stocks that were so undervalued that even if the company were broken up, its assets would be worth more than its market value. Buffett has taken that a step further and now considers intangible assets (one's you can't touch) such as a company's reputation. When he bought stocks in Coca-Cola he looked at the company and thought that even if you had billions and billions of dollars you could never replicate the position that Coke has in the market today. Its investment in its brand over many years was worth far more than its stock price. So buying it was a really safe investment because you were getting, for example, two dollars worth of company for every dollar invested.

Mr Buffett's success is hard to replicate because he is an exceptional stock-picker, perhaps one in a billion. But his philosophy is sound. Look for good, well run businesses to invest in and act as if you are an owner of the business, not someone trading in and out of the stock for a quick buck. Over many years the right companies can deliver exceptional growth.

Beware salesmen promising high returns or quick money investments

David Swenson's High Return Investments

Another exceptional investor of his generation is David Swenson, who manages Yale's endowment fund and who has produced fantastic results for decades. In his fund, Mr Swenson has teams of top analysts and he can meet with the very best hedge funds and private equity funds. So he can put the university's money to work in places that will earn the best returns ever and that are often out of reach of the ordinary investor.

Now many ordinary investors will have heard about hedge funds and want in on the action so they will go through hedge fund of funds. These are middle men who will take your money, charge you an annual management fee, and then select hedge funds for you. They will generally promise to make high return investments to justify the high fees they charge. That sounds fine in theory but what does Mr Swenson think.. He says don't touch them with a barge pole. Unless you understand exactly how your hedge fund will make money and have the skills and experience to choose which hedge funds will do well, you are better off staying away from them. Remember that many of the "fund of funds" that promised their clients high returns had in fact put their money with Bernie Madoff. So much for them earning their high fees.

Mr Swenson's answer is different to Mr Buffett's, but it shares a similar principle, which is to make money slowly. David Swenson suggests a mix of index tracking funds with low costs that track stocks, bonds and property. I talk a bit more about his asset allocation strategy in another post. His allocation is probably the least exciting you will find. Many investment advisers would look at it and suggest you get into racier sectors or funds. But the truth is that unless you can pick stocks like Warren Buffet (and maybe you can) you are better off investing in a diversified portfolio that will generate good returns year after year. The returns may look relatively low (8-10%) in any year, but over time they will build up.

In short, the best way to make high return investments is not to gamble or race after new things, but to play it really safe and follow the advice of two sages of the investment markets.

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